Open Banking: Has the penny dropped for UK lenders?

Fueled by the pandemic, the lending landscape has changed drastically in recent years. Amongst other things, the meteoric rise of Buy Now Pay Later (BNPL) services and increased up-take of online banking has resulted in consumers who now, in addition to demanding seamless and embedded experiences when engaging with financial products and services, view safe and contactless interactions as a key priority.

Fortunately, open banking – a secure method for consumers in the UK to share their bank account information with service providers in exchange for a product or service – presents itself as an opportunity for lenders looking to navigate the complexity of this evolving landscape.

Organizations authorized as Account Information Service Providers (AISPs) can access an individual’s account information, such as their transactional data, to provide a service through the regulation that open banking provides.

Lenders are increasingly partnering with AISPs for access to this data in order to drive efficiencies, reduce friction, and ultimately better serve their customers so that they can deliver against such increased customer expectations.

For instance, where lenders would traditionally require customers to provide evidence of  creditworthiness by setting out their income through bank statements or payslips (a process which could take weeks), innovative lenders are instead using the services of AISPs to streamline this process.

Instead of sifting through and collating a vast amount of paperwork, customers are simply required to connect their bank account(s) to the AISP and provide consent for their personal financial data to be securely shared between the two parties. Once consent is provided, the customers’ data is immediately fetched by the AISP, compiled, and presented to the lender in a readable manner, allowing them to achieve the same outcome in seconds.

As well as helping to provide near-instant income verification checks, open banking also supports lenders in meeting their responsible lending obligations, which includes treating customers fairly and protecting those considered vulnerable; as mandated by the Financial Conduct Authority (FCA).

Assessments on creditworthiness include estimating the affordability of the loan for the customer. In other words, lenders are required to consider the potential financial impact to the customer if a loan is provided. Such estimations are typically achieved with access to a customer’s credit report (a detailed breakdown of their credit history prepared by a credit bureau) to assess their eligibility for the loan.

Credit bureaus, such as Experian, typically include details such as (i) personal information (e.g., name, current and past addresses, phone numbers), (ii) whether other companies have recently requested a credit report on this particular customer, and (iii) current lines of credit in place (e.g., phone contracts, bills) to generate the credit report and accompanying score.

Lenders that solely use credit bureaus as their only data source for assessing affordability, however, are at risk of imperfect lending decisions, which impedes their ability to meet responsible lending obligations.

For example, for those customers without pre-existing lines of credit, such as those who have recently immigrated, it creates financial exclusion; which limits such groups to higher borrowing costs when they need access to credit the most.

In contrast, the Payment Services Directive 2 (PSD2), from which open banking derives,   allows for AISPs to be connected to all EU member banks, given that it is an EU Directive and therefore applicable in all EU member states. By comparison, UK lenders that leverage open banking are therefore capable of accessing European transactional data to determine an EU foreign national’s eligibility for a loan, despite having no UK credit history.
From the consumers’ perspective, this unlocks new lending opportunities to a previously underserved market.

Additionally, credit bureaus are also unable to report on a consumer’s financial behaviour. Thus, activities such as gambling don’t appear on credit scores, nor do they impact credit reports. This, in turn, can result in lenders unintentionally providing credit to those especially vulnerable.

Open banking can help mitigate this risk to the lenders. With access to a customer’s raw transactional data, AISPs can create a financial footprint for each customer based upon their financial habits, which allows lenders to identify and anticipate potentially vulnerable customers, and take preventative action.

Payment Initiation Service Providers (PISPs) offer an alternative service to AISPS, as they are authorized to initiate payments directly from the customers bank account (as opposed to accessing the customer’s account information). To-date it has been primarily AISPs that have been driving open banking adoption for UK lenders, however the potential capabilities that PISPs could offer lenders through Variable Recurring Payments (VRPs) suggests that this may change.

From July 2022, the nine largest banks in the UK (commonly referred to as the “CMA9”) will be required to provide PISPs with access to their VRP APIs for sweeping use cases. Sweeping is the automatic movement of funds between different bank accounts held in the same customers name, think of them as ‘me-to-me’ payments, i.e., funds being automatically moved from a customer’s HSBC account to that same customer’s Barclays account. Reasons for sweeping could be, for example, a customer looking to maximise optimal interest rates across accounts, which the PISP would automate.

Whilst exciting, however, the real opportunity for lenders here is the possible expansion of the VRP infrastructure beyond the sweeping use cases and into ‘me-to-business’ payments. For lenders, the ability to collect variable payment amounts on an ongoing basis would establish open banking payments as a real alternative to direct debit, offering the same flexibility, but with real-time settlement, no chargebacks and all for reduced fees.

Although still a relatively new concept, the increasing presence of open banking is forcing lenders to become more agile and innovative to remain competitive. Furthermore, this increasing presence is raising the bar of expectations for customers looking for easy access to credit. Whilst “open banking” will probably never come up in ordinary conversation down the pub, it’s a term that will nevertheless be omnipresent in the lending sector. After all, a penny saved through open banking is a penny earned.